In-House Competition, Organizational Slack, and the Business Cycle

Multi-plant firms pit their facilities against each other for production assignments. The present paper studies the consequences of that practice in a model where production is limited by capacity constraints and asymmetric information allows facilities to accumulate slack. The amount of slack per unit of output is shown to be pro-cyclical. Indeed, as capacity constraints become more acute in booms, the power of in-house competition for quota assignments is reduced and slack per unit of output increases, while the opposite is true in downturns. Moreover, in downturns firms may use higher-cost facilities even when lower-cost plants are not running at capacity since this boosts X-efficiency in low-cost plants